chaz - great questions with complex interlinkages
? If interest rates are low, is that not an incentive to take on debt?
Short answer is yes. But to inject some objective reality, I just turn to Enron as an extreme example. Their implosion was based on their ability to satisfy existing obligations. No amount of incremental debt will save them (and it seems a least they will have difficulty attracting lenders at this stage). Business exists in balance. Borrowing more than you can afford to carry is a recipe for disaster, regardless of the cost of carrying more debt.
Which leads to: However, this recession is not due to a decrease in consumer spending (debt or otherwise), but to a lack of business profit due to a lack of business spending.
This begs the question "why is there a lack of business spending".
It's not because consumers reduced their spending, it's because consumers didn't increase their spending enough to make businesses profitable!!!
Business geared itself up in anticipation of profitable enterprise that never materialized. A great information superhighway with no on-ramps to the last mile, for example. "Eyeballs" that failed to glance at their wallets. And so on.
For whatever host of reasons, the profits haven't materialized because the consumers haven't spent. And it no longer seems likely that they will spend. And so now these businesses are retrenching. Laying off employees (who are, indirectly, each others' consumers) and further exacerbating the problem. The credit card companies haven't done much to reduce their rates and because credit card debt is such a large fraction of the US consumer's spending power (and savings are so low), the consumer's perceived cost of capital hasn't changed much.
Unless actual consumer spending changes to the upside, further business retrenchment is quite likely. Which increases the consumer spending gap, which stimulates further retrenchment... This is the flip-side to the tornado. Maybe we call it the whirlpool (as in the thing that forms when you pull the bung out of the tub). Same coriolis force and feedback cycle. Just in the opposite direction.
Compared to the interest on cash savings, isn't business investment a better return on capital than anything else? Not necessarily.
If a business is undersized and growing, and the opportunity cost of business investment outweighs the risk weighted return, then yes.
But a business that is over-sized represents under-performing assets. Adding to a pile of under-performing assets (business investment) is often a recipe for accelerated depreciation.
No amount of throwing new satellites into the air is going to increase the profitability of Globalstar, for example. At some point the balance can even tip over. A potential return of $0.102 on the dollar is unattractive, compared to leaving it in cash and getting $1.02
Which leads to an element you did not raise as a question but which begs an answer: that of risk.
Seems to me that one is certain to return something close to zero (but not negative) on cash. We are now entering the phase of the market where billions evaporate spontaneously - almost overnight. Vis-a-vis Enron. Or ATHM. Or Polaroid. These aren't mere doomed.bomb crackpot business models. I bet they aren't the last of their ilk either.
Even if I'm not allowed to wander so far afield from the Gorillas and Kings. They are not immune from risk. Sure, they do not face risk of failure. BUT: their prices have been bid up in anticipation of much higher than average returns. Their risk isn't that they file for Chapter 11, it's that they fail to achieve astronomical growth of profits.
My only point here is that there is RISK in business investment that is not present in cash savings. Which is the invisible element stacked up against the return potential.
It is not at all clear that the risk weighted return from business investment is sufficiently higher than zero to warrant cash balance transfer.
My personal thinking is along these lines. Not just theory-blabber. As of Nov 30 statement, my investment portfolio distribution was
18.44% cash & t-bill money market,
48.07% fixed income (mostly long gov't bonds),
19.96% preferred shares,
9.38% common shares (sorry, no gorillas - mostly blue chips),
3.75% mutual funds and
0.40% other. Zero debt.
About 98% of my holdings generate cash in some form or another, and the majority (>60%) at very good LIQUID rates of return (~6%) considering the level of risk (~0%). Forget any unrealized capital appreciation that Greenspan has delivered to me in the meantime.
I would need stocks with Price to Real Earnings ratio of about 17 or less and a Growth:Risk ratio of 1.0 to compete. There aren't many of those.
So in short, there may be circumstances where (in one's judgement) it is preferable to remain "in cash" rather than invest in businesses.
At the moment, that is. |
